Bond spreads in the euro zone

The single currency's medical chart

THE euro zone's disease has taken a strange turn since the last summit on July 21st. The medicine that leaders prescribed immediately improved the situation of countries in the emergency room, ie, Greece, Ireland and Portugal, which have all received bail-out loans. But it worsened the condition of those outside hospital who had started to fall ill.

This contradictory effect is apparent from our charts showing the direction of yields on sovereign bonds, which move inversely to the price.

The “spread” over 10-year German bunds is the standard measure of perceived risk. It is the premium, or additional interest, that markets demand for holding the debt of a euro-zone country compared with the bonds isued by Germany, deemed the safest.

Until last month's summit, the worry was focused on whether Greece would be able to repay its debts, and whether its sickness would infect bigger countries. Leaders of the euro area decided greatly to extend maturities on Greece's rescue loans and to cut the interest rate it pays. Ireland and Portugal got the same prescription.

In addition, Greece got a bit of local surgery, in the form of a slight “voluntary” haircut on private creditors. Many think wholesale amputation is what is really needed to save Greece. But for now the aspirin and antibiotics have brought down the fever somewhat, as is apparent in the left-hand chart, Ireland and Portugal are faring better too.

By contrast, the spreads of Italy and Spain (right-hand chart), already sickly, have continued to rise, reaching the highest level since the adoption of the euro. Why is the cure not working? One reason is that these two countries have not asked for, and have not been given, the medicine of emergency loans, so they are still struggling on their own. Another is that the measures promised to contain the spread of the disease – giving the euro area's main bail-out fund, the European Financial Stability Facility (EFSF) greater powers to intervene early in a crisis (see my earlier posting here) – have yet to be approved by national parliaments, which are on holiday. Finally, even if the EFSF's drugs are made available, there are not enough supplies in stock to deal with an economy as large and indebted as that of Italy. It may not even be enough for Spain.

The lending power of the EFSF is being increased to its full headline figure of €440 billion. But many think it needs to be bigger still – five times larger, says one leading financial analyst (see here). The bigger the crisis, it seems, the bigger the dose of cash required. But the question is this: as more countries fall ill and are unable to support the EFSF, who will be left to bail out the euro zone? Already questions are being asked about the creditworthiness of France, the AAA-rated country with the highest debt ratio in the EU.

The measures taken by the euro zone might have had a chance of working had they been adopted six, or even three months ago. But now the infection has got out, and it is fast developing resistance to the standard drugs.

To help you keep track of the state of the epidemic, we hope regularly to update these charts. Watch this space, and our dedicated page on the euro-zone crisis. Readers might also want to keep tabs on our debate on the future of the euro, which is just ending.

The French are the chefs
The Italians are the lovers
The British are the police
The Germans are the mechanics
And the Swiss make everything run on time

Hell is Where:

The British are the chefs
The Swiss are the lovers
The French are the mechanics
The Italians make everything run on time
And the Germans are the police

Surprise! Europeans rather than being a monolithic bloc, are a diverse mixing pot of different cultures, business practices and personalities.

And there shouldn't be one interest rate; Germans are lower borrowing risks than Greeks and should have a lower interest cost. Some regions are more productive, and others are more, er, celebratory. Some are more studious and others are more romantic. Some are more disciplined and others just left business meeting before it began.

The EURO rates should reflect this stereotypes and generalities. Just ask the French what they think of their neighboring countries.

In the worst case scenario, even when some countires default, the worst that can happen is that the euro will loose some value. But bearing in mind the USA is now a thing of the past, that the UK is a thing of the very distant past, that Japan is a sinking ship, i dont really see these countries allowing their own currencies to rise against the euro, particularly bearing in mind that there are some countries in the zone that are in much better shape than any of the named above and that the named countries are chronically sick and are attempting to devalue their own currencies to export their problems.

It seems to me the euro crisis exists only outside of the zone itself. And if the crisis develops the only countries that will suffer are those countries outside the zone as they will loose competativness and the money they borrowed. Certainly from my experience, as a person who is constantly travelling around the zone, i would say there is no crisis at all, it exists only when you leave the zone and it will hit only those outside the zone.

The problem with the Eurozone is not to have a common currency and a single central bank but to retain 17 separate finance departments and treasuries.
While the Euro remains a stable and strong currency and the ECB keeps inflation under control, a majority of Eurozone governments have separately accumulated public debt, proved unable to exert a minimal financial supervision on their banks and, lately, to agree collectively on time on corrective measures.

The issue of a common economic governance parallel to a monetary union is, in essence, a constitutional one and should have been dealt with at Maastricht or even at Lisbon.

It cannot be set up by improvised decisions taken by successive panicky, bickery and closed meetings of heads of states and governments. It needs a permanent, official and democratic institutional framework inserted in the EU Treaty on the same legal footing as the monetary system.

It is still time to engage into a belated revision of the Treaty in the perspective of the 2014 next EU institutional and political stage.

Only if such a reform is at last and at least admitted in principle by Eurozone governments will the provisional dams against domino state bankruptcies stand the strain of the current crisis.

Looking at Greece, the principal concern is 4.6% inflation against 2.5% in the wider Eurozone.

This high inflation is caused by massive capital inflows into Greece: even while Greece runs a massive current account deficit (spending far more euros on imports than it earns on exports), the country still has ever more euros in circulation, due to bail out loans, ECB bond purchases, and private sector capital transfers.

Why do we continue to throw more euros at bad debtors? All that it does is prevent the deflation (aka internal depreciation) that would restore competitiveness and bring stability.

"Too big to fail" is an interesting phenomena - it creates enormous systemic risks, where the default of a single creditor poses the risk of a liquidity crisis. This is of obvious relevance at the nation state level.

Imagine the chaos if, say, Lyon were to declare bankruptcy. Or Cornwall. Or the hypothetical UK highway construction agency? Markets wouldn't so much as hiccup. If national debts and accounts were disaggregated to local and function specific entities, each with contractually negotiated income streams and spending obligations, then there would be no systemic risk.

When specific bets went bad, creditors would take a hit, but there would be no systemic risk of the "vanished trillion dollars" with consequent shit dichotomy: liquidity-crisis-and-deep-depression or international-intervention-with-loss-of-sovereignty-and-enormous-cost-to-taxpayers.

National debt should be kept at levels to really guarantee no risk of default: debt funding should never be above say, 25% of discretionary revenues, implying debts typically less than 30% of GDP. If it makes economic sense to raise more capital for public investment (in highways, education, ports, etc), then these funds should be raised by bodies with independent accounts and disaggregated default risk.

Interesting overview. @Cutters Your analysis is flawed. If a group of states decides to pool sovereignty, its members are by definition not "clients". Just as (say) Germany's states are not "clients" of Berlin.

I am glad to see you have a Euro-crisis page. Politically this blog is really good, but right now economic comment and analysis is where it's at. This really is a moment in the economic history of the world that demands expert analysis. Sorry if this sounds a little negative, but it does seem to me that your rivals in the FT are snappier with comment on the European economic situation.

Bond spreads are 'old fuddy daddy' economics. Are you all still stuck in munafiq economics of pre-2009 Global Liquidity Crisis?
Look at Japan near zero interest rate and Public Debt to GDP ratio at 225%.
All that money creation for the sick OECD banks n the 2008-2009 Global Money Mess and you cannot think one up better for Greece. Maybe a stint at China’s Central Bank can be the necessary economics re-education for those in EU.

One currency can only work if you have fiscal union and some stabilizing transfers!

Like in the US where you have West Virginia and California... different economies, but West Virginians can still join the US army, get unemployment checks, work for the gov. this is all a transfer which you do not have in the EU.

SO either we make the next step, fiscal union plus EU military, or a step back national currencies and a free trade zone...

I am for the second one because when I see the approach the south has towards privatization, hard work and transparency of the government I know those are not the people whose votes should affect the north....

Just one example 60 mil Italy has more government cars than the USA!!!

The yield curves are indeed steepening in PIIGS, but without corresponding rates of inflation or tax hikes those economies will have to default with the present framework. The EFSF is just one of patchy measures; if the taxpayers of the current-account surplus countries in the area, such as Germany and the Netherlands, remain as tight, crises will become pandemic.

The only remaining solution is modifying the framework. That is, the Eurobonds or the beginning of the fiscal union. This means not only the euro area states but all the European Union member states have to give up much more of their sovereignties and transfer them to Brussels.

Is like an iceberg, they cut the ice on the top only to appear a bit more and so on, nobody knows how deep it is. It could be to late to realize that France is the last frontier. At that time no more ammunition available.
The future will start at this point

Hi,
The patient Economy medical chart. Open source confidential information. The patient has DOW constipation with Euro Stoxx-50 enlarged and tortuous veins. It also has a high Nesdaq of 39 degrees with kidney gold stones and vomits Raw oil. The condition of dollars in the left ear and Euro's in the right give course for concern. The past future's have now gone. A differential diagnosis of CAC-40 and Frogkinton's manifested by jumping with intermittent kebab Nat-100 and AEX skin bulbs. The PSI-GERAL and the Comp-insect has now gone. The medication as follows 10mg SMI, 5 mg WIG, 0.001 mg FTSE.
Yours Dr. Terence Hale

Hi,
The patient Economy medical chart. Open source confidential information. The patient has DOW constipation with Euro Stoxx-50 enlarged and tortuous veins. It also has a high Nesdaq of 39 degrees with kidney gold stones and vomits Raw oil. The condition of dollars in the left ear and Euro's in the right give course for concern. The past future's have now gone. A differential diagnosis of CAC-40 and Frogkinton's manifested by jumping with intermittent kebab Nat-100 and AEX skin bulbs. The PSI-GERAL and the Comp-insect has now gone. The medication as follows 10mg SMI, 5 mg WIG, 0.001 mg FTSE.
Yours Dr. Terence Hale